Covered bond purchase programmes and a catalytic role in support of the ECBC covered bond label are examples of steps taken by the Eurosystem to address collateral scarcity, said ECB executive board member Benoît Cœuré in a speech on Monday, which noted that covered bonds have lately become the largest marketable asset type in its collateral framework.

Delivered on the occasion of a joint central bank seminar on collateral and liquidity hosted by De Nederlandsche Bank, Cœuré’s speech identified collateral scarcity as a topical issue in the euro area, but differentiated it from collateral shortage.

“Scarcity is a fact and not a problem per se,” he said. “Allocating scarce resources through prices is the way our economies work. The problem would be a shortage of collateral and/or an impaired price mechanism.”

However, this is the not the case in the euro area, according to Cœuré, as there is no aggregate shortage of collateral there with local tensions being addressed in various ways.

Benoît Cœuré

Collateral scarcity can be driven by regulatory changes as well as increased risk aversion and counterparty risk, he said, noting that there is some leeway in collateral availability despite fears of collateral scarcity in the euro area. Out of an average Eu14.3tr of eligible collateral during the second quarter of 2012 only Eu2.5tr was put forward as collateral by counterparties to be used in the Eurosystem’s liquidity operations, he said, acknowledging that these figures mask country differences.

In terms of the composition of assets used as collateral Cœuré noted that the ECB’s longer term refinancing operations (LTROs) in December and February led to an increase in posted collateral in general, in particular covered bonds, which have lately become the largest marketable asset type in the Eurosystem’s collateral framework.

A structural change in the demand for collateral, said Cœuré – for example as the result of a shift from unsecured toward secured funding arrangements fuelled by regulatory changes such as the liquidity coverage ratio under Basel III or proposed capital charges in Solvency II – may warrant changes to central banks’ eligibility criteria for collateral. This would be to prevent central bank operations adding to the overall demand and competition for high quality and liquid collateral for banks, with central banks’ freedom from liquidity risk in their national currency implying that they could choose to accept high quality assets, but not necessarily liquid assets.

To increase access to available collateral, added Cœuré, the three typical medium to long term wholesale funding sources (secured, unsecured and securitisation) need to function properly, as complements rather than substitutes given the different way in which they “slice risk”.

“This may be of particular relevance to the ABSs,” said Cœuré, “since unlike covered bonds, they are based on an extremely versatile underlying pool of assets, and therefore the underlying economic sector that it is funding.

“This makes it somewhat different to other secured assets, for example, covered bonds. Maintenance work is ongoing especially in respect of the covered bond and the ABS market segments, which is indeed a welcome move.”

Cœuré said the Eurosystem has taken several steps to make the supply of collateral assets by financial institutions “more elastic” by encouraging the creation of new assets or making it easier to mobilise existing ones, steps that he said have also contributed to restoring the impaired monetary policy transmission mechanism.

The action cited by Cœuré includes widening the Eurosystem’s collateral framework to accept marketable assets in foreign currencies, interventions in support of the covered bond markets, and leading or playing a catalytic role in support of projects such as the Prime Collateralised Securities (PCS) initiative in the ABS market, and the European Covered Bond Council’s covered bond labelling initiative.

Interventions in support of the covered bond markets through two Covered Bond Purchase Programmes (CBPPs) were aimed at reactivating the primary market, said Cœuré.

“Both programmes had the objective of easing funding conditions and encouraging institutions to maintain or expand lending to their clients,” he said, “thereby contributing to the Eurosystem’s role in supporting the functioning of financial markets.

“By performing this catalytic function, the first purchase programme was very successful in restarting activity in primary covered bond markets, and thus creating private collateral of good quality.”

The PCS initiative and ECBC Covered Bond Label are examples of efforts to improve financial market conditions and to increase transparency and standardisation in some market segments, according to Cœuré, and have in common the aim of restoring confidence among investors in these market segments, and reintroducing them as sustainable funding tools for banks.

For banks to be able to attract investors to the unsecured bank funding market as well, confidence in the euro area must be restored, said Cœuré.

“But let me emphasise that the only fundamental way to overcome collateral scarcity is to ensure private and public deleveraging as well as sustainable growth,” he added. “It is growth that generates sound assets, i.e. securities which guarantee a high likelihood stream of revenues.”

Photo: OECD/Michael Dean